Video: Setting the Advertising Budget: Definition & Approaches

Setting a budget is crucial when a company is determining how much money to spend on advertising. In this lesson, we will discuss the importance of advertising and three options that can help set a budget for it: the percentage method, objective & task method, and the competitive parity method.2017-04-20

Sean has 8 years experience as a supervisor and has an MBA with a concentration in marketing.

Setting a budget is crucial when a company is determining how much money to spend on advertising. In this lesson, we will discuss the importance of advertising and three options that can help set a budget for it: the percentage method, objective & task method, and the competitive parity method.

The Importance of Advertising

Advertising is an essential part of the business process and allows companies to communicate with consumers to promote a product or a service. Advertising informs the consumer about the company, product, and any essential information the company wants to share. It takes time and money to ensure that an advertising campaign is successful. It's essential for a company to set money aside for advertising because it's how messages get conveyed to the customer, with the ultimate goal of convincing them to make a purchase. There are different ways to budget money for advertising.

The Percentage Method

The method utilized by most organizations is the percentage method, which consists of calculating the percentage of sales, sales goals, and gross markup. A company should look at their past sales in order to determine how they should advertise in the future. Sometimes low sales could mean that the company wasn't advertising enough, and high sales could mean that the previous advertising campaign was effective.

Let's take a look at a hypothetical example. The Beachwear Bathing Suit Company had higher sales in the first quarter than in the second quarter. The company decided to take the percentage of sales for both quarters and compare them to advertising expenditures. They realized that their percentage of sales were lower in the second quarter because they cut back on advertising. The percentage of sales method helped them discover that they need to increase advertising again in order to increase sales as well.

Objective & Task Method

The Beachwear Bathing Suit Company wants to promote their new products. It's essential for them first to determine what their objectives or goals are. The objective & task method determines a company's goals and then assigns money depending on the task that needs to be completed. It's important for businesses not to spend too much money on advertising, especially when they're new and don't have the money to run massive campaigns.

It's essential for a company to be able to complete an advertising task fully by making sure the company has enough funds in place. Imagine if you were shooting an advertisement and halfway through there was no money left. This would cause the company to look unprofessional, and the task could not be completed.

For instance, the Beachwear Bathing Suit Company wants to start an advertising campaign via television commercials, as well as run a campaign on social media. The company would have to allocate more money for the television commercial because that will be a larger project than the social media campaign. It's essential for the company to determine which advertising techniques require more money and to allocate the budget accordingly.

Competitive Parity

Competitive Parity takes a direct look at what other leading companies in the same industry are doing and compares budgets. Comparing your advertising budget to your competitors' advertising budget is beneficial because you can learn what advertising channels they are using and how much money they're putting into each channel.

Let's say you own a chain of Italian restaurants and have less money in sales than one of your main competitors. You'd want to analyze your competition and see how much they're spending on advertising compared to you. Once you realize that they're advertising a lot more and have more sales as a result, this should motivate you to start promoting your business more via advertising.

As a business, you must continue to stay competitive and try and outperform the competition. It may be difficult to match the competition's advertising budget if you're a new company because they've already established significant profit to spend on advertising. Although you may not have the financial resources to produce massive campaigns right away, it's still essential to advertise your business. As sales continue to increase, advertising can increase as well.

The Beachwear Bathing Suit Company needs to develop their advertising campaign further. They decide to look at what competitors are spending and spend the same amount of money. The problem they're running into is that they have some large competitors and cannot afford to spend as much as their competitors. The company has other advertising budget options it can choose from, but in the future, after establishing more sales and a larger budget, they can return to this method.

Lesson Summary

Setting an advertising budget is essential to make sure that money gets allocated correctly. One way to do this is through using the percentage method, which examines sales numbers as well as the percentage of the budget used for advertising. This allows a company to assess and determine the future advertising budget. The objective & task method analyzes company goals and distributes funds based on the necessary tasks. The competitive parity method assesses competition and decides how much of an overall budget should be spent on advertising, compared to leaders in the industry.

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